Derek, can you explain how to invest using Exchange Traded Funds?
Exchange Traded Funds (ETFs) are a rapidly growing investment product with an ever-expanding list of choices. They were introduced as a way to offer an investment with very broad diversification that can be readily sold and bought through various stock exchanges. Today they make up a massive part of the investment spectrum with approximately $2-trillion invested. Before you decide to add your money to the pile, you should understand that not all ETFs are created equally.
Since the early days from a handful of ETFs which were largely focused on the indices, there are now nearly 5,000 different choices with numerous investment options available. Today, ETFs can be based on an index, a specific sector, bonds, commodities, or even currency.
At the most basic level ETFs are a basket of other investments bundled into one accessible investment. The original ETFs were developed to mimic various stock indices. The thinking is that instead of picking a few different stocks on your own, you could simply buy the ETF and you would own all the companies in that index. The basket, therefore, was a weighted position in each of the constituents in a stock index.
Some ETFs are considered passive investments. Passive ETFs simply follow the weighting in their given index or criteria and are rebalanced at a specific point – said another way, there often is no portfolio manager making decisions, instead the fund simply follows pre-determined rules. An index-based ETF is an example of a passive investment. Other ETFs are considered active investments. Active ETFs have a portfolio manager adjusting the underlying basket according to their investment mandate and market perceptions similar to a mutual fund.
As the name implies, ETFs trade on stock exchanges around the world and can be bought and sold through the trading day. This allows investors to make quick decisions and gain instant exposure to a given sector or index. ETFs make up a considerable amount of trading volume in any given day due to their broad holdings and popularity. The attractiveness of their liquidity has been a big reason for their increased use.
Passive ETFs also have a lower fee structure than most mutual funds. Since there is no portfolio manager, the cost of managing the fund tends to be less. This may be an attractive choice for investors, but one needs to consider the cost of the trading commissions tied to buying and selling before diving into ETFs. Active ETFs may have much higher fees, but can in some cases be cheaper than a similar mutual fund before factoring in trading costs.
With the increased use of Exchange Traded Funds more volatile and risky options have become available. There are now ETFs that offer built-in leverage intended to enhance returns, essentially allowing the investor to borrow money which in turn multiplies the money they have invested. I believe these are extremely risky products and often should only be held for a business day or two. There can be phenomenal losses in leveraged ETFs and they should be used with caution.
While Exchanged Traded Funds offer an ever-growing catalogue of choices and are gaining a larger market share each year, it may be best to review these options with a qualified Wealth Advisor prior to building your portfolio.
Happy investing,
Derek Fuchs
Senior Wealth Advisor
Scotia Wealth Management